Value creation is amongst the strongest drivers for most businesses when considering outsourcing arrangements. On the topic of how to create value in outsourcing, factors such as cost optimization, risk mitigation, and innovation are usually the first items that comes to mind. Unfortunately there is significant difficulty in achieving these seemingly conflicting ideals. Value is killed instantly when only one of these factors is out of alignment. In fact, this the primary cause for disappointment – given the complexity, costs and general disruptiveness of outsourcing.
When preparing an outsourcing arrangement, it is best to first try and identify these value killers. There are 2 main areas of value killers to consider and these are either structural or executional in nature. the challenge is to try and get both of these areas right.
What is structural?
These usually refer to facets of the deal that are regulated: the tax, employment, privacy and other regulatory matters. This inherently means that where enough analytical attention is applied, your business can plan to avoid any potential pitfalls and strategize so events are predictable. For example, certain data must be handled a certain way and structuring the arrangement in a certain way may optimize the tax benefits. This allows for a significant mitigation of risks setting up the outsource arrangement to achieve the best possible value.
Execution level value killers
These refer to the performance –related issues that lead to poor outcomes. In our experience, the root cause usually comes down to a bad choice of outsource partners. Many factors may have led to this outcome, however, the mentality towards outsourcing of recent years almost guarantees failure. We attribute this to the complacency of many businesses when approaching the topic of outsourcing: by taking a commoditized view to outsource arrangements. In other words – outsource partners are almost evaluated exclusively on a quantitative basis. This bias consequently leads to the awarding of a contract to an unsuitable supplier. This type of evaluation misses the critical underlying business requirements for the arrangement- the “soft” terms.
This usually then escalates to the parties looking to the resulting contract for help. The businesses may hold what is a legally sound contract – but since the terms were “forced” on the outsource provider with their “pre-contract power” they typically change dramatically upon actual execution of the services. So the contract becomes an enforcement tool rather than a business enabler. Whilst we agree that the contact may be a powerful fallback on coerce the “right” behaviour from the outsource partner- whatever goodwill in the relationship has long dried up. To maximize the value of any outsource arrangement – both parties must have goal congruence.
Invariably, outsourcing arrangements are the most vulnerable at the transition phase. Businesses often try to stipulate unrealistic transitional commitments on the outsource provider. This almost guarantees failure. Typically, during the transition phase, the business is heavily impacted by the disruptions as a consequence of the arrangement. This is the time when end users feel the most insecure about the services being performed by the outsource provider. We expect that most of us have heard this classic case of “downward spiral” before: the first turn is when the supplier fails at the unattainable terms, the natural reaction of the business’s end-users to enforce the contractual terms and so on…
As evidenced, a transition burdened by unmet expectations can make a perfect outsource partner look incompetent. This is the specific reason outsourcing loses credibility. Once this is credibility is lost, it is extremely difficult to recover the lost ground. Both parties will spend more energy on defense while the value of the arrangement evaporates.
So, for successful create value in outsouring, it is of paramount importance for businesses to analyze and manage both the structural and the execution or dynamic value killers. While risks are “mitigated” in the traditional-sense a structurally sound deal may not drive the business value being sought. Being effective at mitigating the risks and deriving genuine business value requires sound commercials and technical delivery in additional to a solid compliance and legal foundation. Dynamic value killers can be difficult to mitigate – but without fully appreciating these – you are not getting the best deal.